ETLA Discussion Papers, The Research Institute of the Finnish Economy (ETLA) 923

Abstract:

Using patterns of disagreement between credit rating agencies, Donald P. Morgan (American Economic Review, 2002, Vol. 92, No. 4, pp. 874-888) shows that financial institutions are more opaque than other types of firms. In this paper we employ this novel measure to study the determinants of ‘opacity’ of small and medium sized enterprises (SMEs). We explore them, because a conventional wisdom in the contemporary corporate finance literature postulates that financial constraints are especially acute for younger firms due to their informational opacity. The patterns of disagreement in a large Finnish firm-level panel dataset allow us to render this article of faith to that of fact: The disagreements are inversely related to the age of firms, suggesting that younger SMEs are indeed more ‘opaque’ than older firms. We can also to an extent replicate Morgan’s finding: Two local credit information companies split more often over SMEs from the financial services sector than over other firms. The data also support the idea that the probability of disagreement is highest for those firms who have an intermediate rating, because they are, almost by definition, those whose quality is most difficult to evaluate. – opacity ; small business finance ; financial constraints